Brookings Panel on Economic Activity: Spring 2012

NOTE: MOST OF THESE COMMENTS WERE NOT REPEAT NOT DELIVERED AT THE CONFERENCE:

"Fiscal Policy in a Depressed Economy", by J. Bradford DeLong, University of California, Berkeley and Lawrence Summers, Harvard University.

"Disentangling the Channels of the 2007-2009 Recession", by James Stock, Harvard University and Mark Watson, Princeton University:

Comments: Stock and Watson say policy uncertainty is liquidity squeeze is risk spreads: there is one single "financial shock". Stock and Watson say the old factors and old coefficient macro dynamics predict the macro dynamics of this recent recession. Thus the current business cycle is still the standard business cycle--only bigger, driven by bigger financial shocks. Alan Blinder queries: how can this recession be the same? It wan't caused by either inflation-fighting monetary policy or by an oil shock. So it ought to have been different, shouldn't it? In Ricardo Caballero's framework, a normal post-WWII recession was caused by a liquidity squeeze, but this was caused by a safety squeeze--there would have been a liquidity squeeze if not for extraordinary Fed action, and Milton Friedman would have said that fixing the liquidity squeeze would fix the problem. And it didn't...

If I understood Martin Baily, I think he was wondering whether an error-correction framework would show more of an anomaly in the recent episode. I want to second that.

Comment: First, let me thank Michael Woodford for finally telling me how to pronounce Goy-tee. I have never before dared say anything other than "Eggertsson". Second, the point about nominal levels: when velocity undershot in the early 1980s Paul Volcker laid down the principle that base drift would not be reversd--admittedly, then it was base drift in the money stock. That precedent creates some difficulties for the Fed to adopt level targeting.

Third, with respect to commitments. The FOMC's voting membership turns over rather quickly. That makes commitment difficult. Commitment via appointing central bankers who are conservative in the Rogoff sense in having an unreasoning distaste for inflation solves some commitment problems, but not others. Odyssean commitment via QE is also difficult because QE transactions can easily and costlessly be reversed. So if you are a central bank that wants to commit to a higher future money stock, the natural way to do it is to increase the money supply by expanding your portfolio in ways that cannot be reversed. So, instead of buying GSE MBSs, buy bridges, human capital for twelve year olds, and biomedical knowledge--transactions the Fed cannot unwind. And Eggertsson and Woodford optimal ZLB monetary policy has just become monetary base-financed expansionary fiscal policy.

Comment: Are the quarter of mortgage debtors who are underwater more of a drag on the economy than other homeowners who have lost wealth? Yes, clearly they are.

"The Euro’s Three Crises", by Jay Shambaugh, Georgetown University

Comment: Yes, interest rates have to be very high indeed for austerity to be worthwhile even on the metric of debt service burden alone...

When Jay's excellent paper arrived, I was rereading the late Charlie Kindleberger and thinking about his old line that Europe fell into the Great Depression in the 1930s because the world lacked an international monetary and financial hegemony, and also reading the transcript of the Bretton Woods Conference--where White and Keynes appear well aware of this, and working their hardest to make sure that this does not happen again by creating a hegemon: the IMF. Yet here we are again. And I think it is safe to say that we would not be here, but rather in an at least somewhat better place, either if the IMF had in the late 1990s been recapitalized at much more than its current scope or if Iceland, Ireland, and Greece had incorporated themselves in Delaware as bank holding companies and joined the Federal Reserve System.

If White and Keynes were here now, I think they would yell at us: of course, they would say, a dozen national governments cannot quickly strike a Coasian bargain under these circumstances. You need a hegemony. We gave you a hegemony. What have you done with it?

We are probably going to dodge the biggest bullets coming at us this time. But it really is not too early to start building institutions that will allow us to, next time, avoid both the policy mistakes of the 1970s and the policy mistakes of the 2000s so that we can make new and more original policy mistakes.

Comment: I like the focus of the long-term historical impact of "slaves on horses": the interaction of the ulema and the mamelukes from the Ummayid dynasty on, a pattern found in the regions of the 7th century conquests and the resultant expansion of the community of believers, but not elsewhere. I feel like I should channel the medieval historian Ibn Khaldun and wonder whether it is not 8th century institutions but rather, as Linda noted, desert ecology. The 7th century conquests are (with the exception of what is now Iran) places where desert power is important. And in deserts agriculture is not very productive: it is hard for the ruling institution to tax the surplus. Herding is even harder to tax. So the ruling institution taxes commerce, especially long-distance commerce, and does not embed its revenue sources in society. Thus you get a succession of dynasties playing the game of thrones whose major interest in the bulk of the population is autocratic domination rather than economic development, and this ecologically-driven political-economic equilibrium echoes down the centuries. It is then powerfully reinforced by oil.

Unfortunately, I see only one data point that was part of the 7th century conquests where desert power is not terribly important: the collapse of the Sassanid Empire. While the Byzantine Empire survived, and held the line where the desert turned into the Anatolian Plateau, the Sassanids collapsed and the Arab Conquest extended over the Iranian Plateau.

If Iran makes a successful democratic transition in the next fifty years, I would characterize that as strong evidence against Eric's hypothesis.

Comments

NOTE: MOST OF THESE COMMENTS WERE NOT REPEAT NOT DELIVERED AT THE CONFERENCE:

"Fiscal Policy in a Depressed Economy", by J. Bradford DeLong, University of California, Berkeley and Lawrence Summers, Harvard University.

"Disentangling the Channels of the 2007-2009 Recession", by James Stock, Harvard University and Mark Watson, Princeton University:

Comments: Stock and Watson say policy uncertainty is liquidity squeeze is risk spreads: there is one single "financial shock". Stock and Watson say the old factors and old coefficient macro dynamics predict the macro dynamics of this recent recession. Thus the current business cycle is still the standard business cycle--only bigger, driven by bigger financial shocks. Alan Blinder queries: how can this recession be the same? It wan't caused by either inflation-fighting monetary policy or by an oil shock. So it ought to have been different, shouldn't it? In Ricardo Caballero's framework, a normal post-WWII recession was caused by a liquidity squeeze, but this was caused by a safety squeeze--there would have been a liquidity squeeze if not for extraordinary Fed action, and Milton Friedman would have said that fixing the liquidity squeeze would fix the problem. And it didn't...

If I understood Martin Baily, I think he was wondering whether an error-correction framework would show more of an anomaly in the recent episode. I want to second that.

Comment: First, let me thank Michael Woodford for finally telling me how to pronounce Goy-tee. I have never before dared say anything other than "Eggertsson". Second, the point about nominal levels: when velocity undershot in the early 1980s Paul Volcker laid down the principle that base drift would not be reversd--admittedly, then it was base drift in the money stock. That precedent creates some difficulties for the Fed to adopt level targeting.

Third, with respect to commitments. The FOMC's voting membership turns over rather quickly. That makes commitment difficult. Commitment via appointing central bankers who are conservative in the Rogoff sense in having an unreasoning distaste for inflation solves some commitment problems, but not others. Odyssean commitment via QE is also difficult because QE transactions can easily and costlessly be reversed. So if you are a central bank that wants to commit to a higher future money stock, the natural way to do it is to increase the money supply by expanding your portfolio in ways that cannot be reversed. So, instead of buying GSE MBSs, buy bridges, human capital for twelve year olds, and biomedical knowledge--transactions the Fed cannot unwind. And Eggertsson and Woodford optimal ZLB monetary policy has just become monetary base-financed expansionary fiscal policy.

Comment: Are the quarter of mortgage debtors who are underwater more of a drag on the economy than other homeowners who have lost wealth? Yes, clearly they are.

"The Euro’s Three Crises", by Jay Shambaugh, Georgetown University

Comment: Yes, interest rates have to be very high indeed for austerity to be worthwhile even on the metric of debt service burden alone...

When Jay's excellent paper arrived, I was rereading the late Charlie Kindleberger and thinking about his old line that Europe fell into the Great Depression in the 1930s because the world lacked an international monetary and financial hegemony, and also reading the transcript of the Bretton Woods Conference--where White and Keynes appear well aware of this, and working their hardest to make sure that this does not happen again by creating a hegemon: the IMF. Yet here we are again. And I think it is safe to say that we would not be here, but rather in an at least somewhat better place, either if the IMF had in the late 1990s been recapitalized at much more than its current scope or if Iceland, Ireland, and Greece had incorporated themselves in Delaware as bank holding companies and joined the Federal Reserve System.

If White and Keynes were here now, I think they would yell at us: of course, they would say, a dozen national governments cannot quickly strike a Coasian bargain under these circumstances. You need a hegemony. We gave you a hegemony. What have you done with it?

We are probably going to dodge the biggest bullets coming at us this time. But it really is not too early to start building institutions that will allow us to, next time, avoid both the policy mistakes of the 1970s and the policy mistakes of the 2000s so that we can make new and more original policy mistakes.

Comment: I like the focus of the long-term historical impact of "slaves on horses": the interaction of the ulema and the mamelukes from the Ummayid dynasty on, a pattern found in the regions of the 7th century conquests and the resultant expansion of the community of believers, but not elsewhere. I feel like I should channel the medieval historian Ibn Khaldun and wonder whether it is not 8th century institutions but rather, as Linda noted, desert ecology. The 7th century conquests are (with the exception of what is now Iran) places where desert power is important. And in deserts agriculture is not very productive: it is hard for the ruling institution to tax the surplus. Herding is even harder to tax. So the ruling institution taxes commerce, especially long-distance commerce, and does not embed its revenue sources in society. Thus you get a succession of dynasties playing the game of thrones whose major interest in the bulk of the population is autocratic domination rather than economic development, and this ecologically-driven political-economic equilibrium echoes down the centuries. It is then powerfully reinforced by oil.

Unfortunately, I see only one data point that was part of the 7th century conquests where desert power is not terribly important: the collapse of the Sassanid Empire. While the Byzantine Empire survived, and held the line where the desert turned into the Anatolian Plateau, the Sassanids collapsed and the Arab Conquest extended over the Iranian Plateau.

If Iran makes a successful democratic transition in the next fifty years, I would characterize that as strong evidence against Eric's hypothesis.